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New UK Regulation Provides a Best Practices Template for P2P Lenders

by Peter Renton on October 24, 2013

Many people say that equity crowdfunding and p2p lending are related cousins since both allow people to provide investment capital to other people. So it is interesting to see that while the US regulators have been creating regulation around equity crowdfunding as part of the JOBS Act, the UK regulators have been concurrently designing regulation around p2p lending.

Coincidently, the SEC voted yesterday to propose rules around equity crowdfunding while the UK’s equivalent body, the FCA, issued this consultation paper today to propose rules around p2p lending. If all goes according to plan, then US equity crowdfunding will be implemented in January 2014 and UK p2p lending regulation will be implemented in April 2014. In this post I provide a little history on the UK government’s involvement with p2p lending and I highlight some pointers on best practices and regulation that could eventually make their way across the pond to the US.

How the UK Government is Involved in P2P Lending

Unlike in the US where we have a massively distributed banking system with over 7,000 community banks, in the UK the banking system is highly centralized with approximately 90% of all lending completed by only five big banks. In both the US and the UK, the big banks have pulled back on lending to consumers and small businesses. This tightening has been greatly magnified in the UK due to the lack of alternatives. UK consumers and small businesses have struggled with virtually no access to capital.

In their first try, the UK government tried to accelerate lending by creating a program called Funding for Lending where the government provided low cost capital to the five big banks to encourage them to lend to small businesses. This initiative has failed miserably. As a result, that low cost government money has ended up building up bank balance sheets rather than trickling down to consumers and small businesses.

The UK government’s second try has worked much better so far. In late 2012 the Department of Business Innovation & Skills (BIS) created the Business Finance Partnership initiative. This initiative has dedicated £100m to alternative lending platforms to help fund small businesses and consumers. Two leading p2p lenders were the recipients of a good chunk of this money: Funding Circle received £20m and Zopa received £9m. As I mentioned yesterday this £20 million is being indexed across all of Funding Circle’s new small business loans with a 20% allocation to each deal. As a result of its early success, BIS has announced a new £300m initiative to expand this lending program. The initiative has accomplished two objectives: 1) it is providing credit worthy consumers and small businesses with much needed access to capital, and 2) it is providing credibility and awareness to alternative lenders in the UK.

Bring on the Regulation

Back in 2011 the three leading UK p2p platforms, Zopa, RateSetter, and Funding Circle, decided to band together to create a self-regulating body called the P2P Finance Association, which has since been joined by additional UK p2p platforms. This association proactively approached the UK government and asked to be regulated as a separate entity. The UK government has agreed and is in the process of developing a framework for regulation, a major section of which was released by the FCA today, and is expected to be implemented in April 2014.

The components of the regulation are broken into three categories: business practices, investor protection, and consumer regulation. In the first category, business practices, the regulation focuses on how p2p platforms should deal with clients and how to maintain proper capital requirements. In the second category, investor protection, the regulation focuses on how the platforms and their websites communicate investor information, standardization and communication of returns, and how to properly outline the risks associated with p2p investing. Finally, in the third category, consumer regulation, the regulation focuses on how p2p consumer regulation coexists with other forms of UK consumer lending regulation.

What the US can Learn from UK Regulation

Regulation for the US p2p market is divided between the investor side and the borrower side. Since 2008 the SEC has provided oversight on the investor side and Lending Club and Prosper have spent an enormous amount of time, energy, and capital to build solid SEC compliance.

Regulation on the borrower/platform side is still evolving and there is a lack of clarity on which regulator has final oversight. Bank regulators at the state level often oversee platform regulatory compliance, but those same platforms often partner with national banking entities, like WebBank, and therefore also receive oversight by the FDIC or the Federal Reserve. In addition, the CFPB has begun providing regulatory oversight in the student loan sector and, as reported by eBay earlier this week, the CFPB is taking an increased interest in the online consumer lending segment. And if you have been following along for a while, you may remember the GAO report released in the summer of 2011 that also talked about the CFPB as a possible overseer of this industry.

In my conversations with US regulators, I know that members of the Treasury, the Fed, and even President Obama’s economic council are closely watching these developments in the UK as they search for ways to help consumers and small businesses access capital here in the US. After my initial review of these regulations, it is apparent that US p2p lending platforms should read this consultation paper cover to cover and try to implement many of the policies set forth.

In particular, this paper proposes rules in the following key areas:

  • Minimum requirements that firms must meet in order to ensure their ongoing viability
  • Bankruptcy remote structures that ensure that existing loans can continue to be managed in the event of platform failure
  • Rules on holding client money to minimize the risk of loss due to fraud, misuse, poor record-keeping, and to provide for the return of client money in the event of a firm failure
  • Rules on resolutions and disputes
  • Reporting requirements for firms to send information to the FCA in relation to their financial position, client money holdings, complaints and loans that they have arranged
  • Rules on investor net worth to participate on these platforms

The FCA regulation has been welcomed by the UK p2p lending community. It is encouraging to see best practices take shape through this regulation. It would be helpful if a similar self-regulating body emerges in the US to push forward similar regulations here.

{ 7 comments… read them below or add one }

Simon Cunningham October 25, 2013 at 12:33 am

This is great. I’m eager for standardized regulation to possibly enable a sense of calm within this new avenue that sometimes feels frenetic. It feels like some static guidelines could really help protect both borrowers and lenders who don’t have the financial sway to be their own advocates. And I wonder if a common regulatory practice could further standardize the platforms more than they are.

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Peter Renton October 25, 2013 at 5:32 am

Thanks Simon. Yes, I think we can learn a lot from our UK brethren here. And maybe a more rigorous attempt at self-regulation would please some of the stubborn states that refuse to ratify p2p lending as an investment for their residents.

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Simon Deane-Johns October 25, 2013 at 7:54 am

Hi Peter, an excellent piece, although in my view the UK proposals are still too heavy-handed when it comes to P2P lending (or ‘loan-based crowdfunding’ as the FCA calls it), as opposed to investment-based crowdfunding. However, we still have the weird inconsistency that it’s easier to blow your money on the ponies than to back a small business: http://sdj-pragmatist.blogspot.co.uk/2013/10/crowdfunding-regulatory-arbitrage.html. My take on the UK proposals is here: http://sdj-thefineprint.blogspot.co.uk/2013/10/fca-crowdfunding-consultation.html

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Peter Renton October 25, 2013 at 10:04 am

That is one of the things I don’t get about the regulatory environment here. Anyone can put their entire life savings into a penny stock or even a futures contract, both highly risky investments. In many states that is completely fine but investors are banned from p2p lending. National regulations here would help create some consistency here between states and that would be a good thing.

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Josef Davies-Coates November 17, 2013 at 5:29 am

Yes, I couldn’t agree more. It is fine to gamble or give away your money, but people aren’t allowed to invest it in productive assets. It is utterly absurd and it makes claims that regulation is about protecting the savings of customers highly questionable. I would seem to me that it is really about is raising the barrier to entry and stopping more people from owning productive assets.

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Peter Renton November 18, 2013 at 12:48 pm

Your point is taken. There is no regulation that will prevent people from betting their life savings on the blackjack table or one speculative penny stock. But I think regulation is a good thing. In the UK right now, any 21 year old who can create a website can launch a p2p lending company. Having some barrier to entry is a good thing overall in my opinion.

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Niti Gupta October 30, 2013 at 10:31 pm

This is excellent news for P2P lending and we (i-lend.in) in India are also working towards similar attempts at regulation, though we are a little behind the US & UK.

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